When financing a start-up or small business, new business owners sometimes feel that the funding they need is out of reach if they don’t have the collateral to secure it. However, this isn’t always the case – unsecured business loans are an option for getting the capital you need without having to put up an asset as security.
What is an unsecured business loan?
When you take out an unsecured business loan, you won’t need to set the loan against assets as collateral. This means higher exposure or risk for the loan provider. For this reason, lenders may mitigate risk by lending smaller amounts over a shorter time.
What is a secured business loan?
A secured business loan, on the other hand, gives the lender better security by using one of the business’ assets (such as machinery or property) as collateral in case the business owner fails to repay the loan. Should the borrower become unable to repay all of its debts, the lending institution will be the first to receive repayments over the secured asset. Generally speaking, a secured business loan may be more flexible in terms of repayment periods. A secured loan may also have a lower interest rate than an unsecured loan as the lender has some form of guarantee.
Who can benefit from unsecured business loans?
Some examples of businesses that can benefit from unsecured business loans include:
- Seasonal businesses – Businesses that boom during certain times of the year and are quieter at other times may seek an unsecured loan to cover the gaps in working capital during the quieter months. Once business picks up again, they will pay the loan back.
- New businesses – Start-ups may not have sufficient assets to use as collateral.
- New investment – When businesses need to finance a change or asset to help them grow the business.
What will you need to take out an unsecured business loan?
Each lender’s requirements vary, but here are some of the things you may need to take out an unsecured business loan?
- Your business’ turnover figures
- A personal guarantee (a legal document that states that if you can’t pay back your loan, the lender will have legal rights to pursue your personal assets)
- A legal loan document
- A breakdown of your business assets, expenses, how much money you have in the bank and your plan for the money provided by the loan
- Business plans, projections and financial forecasts
The Pros of Unsecured Business Loans
Free up your assets
Since you haven’t used your assets as collateral, you can sell or replace them as you please without seeking permission from the lender.
Fewer upfront costs
Since there are no legal and valuation costs, the upfront costs of an unsecured business loan can be lower.
No risk to personal or business assets
Because a secured business loan is protected with specific assets, the lender is able to take control of these assets if you default. In the case of an unsecured business loan, the lender would have to go to court to secure an order to seize any assets.
Easier loan application process
With an unsecured business loan, lenders don’t need to conduct external reviews to evaluate the collateral beforehand. Because the lending process is controlled by the lender, the overall process is faster and easier.
Wider range of providers and products
Because the loan process is easier with an unsecured business loan, this means that more providers are willing to offer them. Institutions can choose to take a higher interest rate in lieu of collateral.
No need for collateral
If your business or startup lacks valuable business assets to offer lenders as collateral, you will be ineligible for most secured business financing. With an unsecured loan on the other hand, there’s no collateral required.
The Cons of Unsecured Business Loans
Smaller loan amounts
Because of the increased risk, many lenders will only loan smaller amounts without security. If you need a larger loan for a major investment, you may need to put up some collateral to bring down the level of risk taken by the lender.
Higher interest rates
Because unsecured loans carry more risk for the lender, they tend to have higher interest rates. If you have collateral to utilise, it may be worth getting a secured loan to avoid high interest rates.
Require a decent credit score
If you don’t have a good credit score, you run the risk of having your loan application rejected by most financial institutions. Since you are not using collateral, your credit score is the only ‘security’ the lender has. It may still be possible to get an unsecured loan with an average credit score, but you may be liable for higher interest rates.
Harder to qualify for a loan
Your business is unlikely to qualify for an unsecured loan if your credit score, business plans, financial statements, cash flow etc. are not in order with the lender’s requirements.
How to get an unsecured business loan
Now that you have a better understanding of unsecured business loans, we hope you have a better idea of whether or not this is the right loan solution for your business. For help finding the best business loan for your needs, don’t hesitate to contact the team at Smarter Business.